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Mark Kleiman asks:
Shouldn’t [GM] bondholders be paid off at the current (extremely depressed) prices of the bonds, and the the stockholders mostly wiped out, as AIG’s were?
When investors bought GM bonds, they entered into a contract with GM that obligated it to treat them as any other senior unsecured lender.
Thus wiping out GM debt would require the same treatment for huge numbers of dealers and suppliers, as well as GMAC, which finances dealers inventory and retail customers, and GM’s pension and retiree medical plans. This would happen anyway in bankruptcy.
I think what he actually has in mind is that only some GM’s creditors be paid. But this would require a government official go through and decide who are the worthy unsecured creditors, and who aren’t, and only have some of them get wiped out. I don’t think it is prudent to have the government to start doing this.
States are specifically prohibited from modifications of contracts such as Mark proposes by the Contract Clause of the Constitution. It would also likely be unconstitutional for the federal government under the Takings Clause, as it seems fairly similar conceptually to the facts in Lucas v. South Carolina Coastal Commission.
As a practical matter, GM would need more financing later. Under Mark’s proposal, this would always need to come from the government, since his proposal would cause debt markets stay closed for GM. Also, if the US government decided that it would capriciously void legal loans it citizen companies owe to foreigners, I think you would also permanently stunt the American economy by making private lending less secure, further raising interest rates.
Similarly, this action would cause GM to violate the contract law of other countries where it has both bondholders and other operations. GMs’ bondholders then could obtain judgments against GM’s substantial property abroad.
Finally, there is no way that we can establish a “market price” for GM bonds. While the value of the bonds are low, they fluctuate wildly from day to day.
Stockholders, however, can easily be wiped out. The government could simply buy from GM 98% of its stock for $50 billion. As we say in finance, this would be a dilutive equity offering.
This would (1) give GM $50 billion to work with and the US gov 98% ownership (and complete control” over the new company, with 98% of the ownership of the profits of its new property (2) cause stockholders have only 2% of the recapitalized company. I have little doubt that GM’s board would not take this offer, which would in theory send GM stock to about 1.63 a share from the current 3.2. When better economic times resume, the federal government recoup its spending by selling GM shares into the open market.
